Tax, like rust, never slept during my RSV enforced break over the past few weeks. Inland Revenue released several interesting Technical Decision Summaries and other guidance material and the High Court ruled on the deductibility of seismic strengthening expenditure in Podium Investments Limited v Commissioner of Inland Revenue.
Now in this case, this was an appeal from a Taxation and Charities Review Authority decision from last year. Podium Investments sought to deduct approximately $460,000 of seismic strengthening expenditure, together with $1.5 million of ground floor glass facade expenditure incurred as part of a major refurbishment of a commercial building located in Hamilton.
The Taxation and Charities Review Authority found in favour of the Commissioner saying that both categories of expenditure were capital in nature because they were an integral part of a wider project that transformed a seismically substandard retail building into a modern compliant office building. The High Court agreed with the Authority’s analysis and also found that the works resulted in significant improvements to the building's character, functionality and value.
No surprises then?
It’s good to get a High Court decision on the issue of repairs as it helps clarify the law. Based on the facts most people would have expected this decision given the significant amount of expenditure involved. The decision ties in with Interpretation Statement IS 26/01 Income Tax – deductibility of repairs and maintenance – general principles that Inland Revenue has put out recently. The High Court decision includes a photograph of the building after the renovation.
We’re not called the Shaky Isles for nothing
However, the decision does highlight a problem with our tax system at the moment, which in my view is going to get bigger. The decision’s release coincided with the recent 5.9 magnitude earthquake near Te Anau in the South Island. In the wake of the Canterbury earthquakes of 2010, 2011 and Kaikoura in 2015 many building owners have been required to undertake a lot of seismic strengthening expenditure.
This is critical expenditure but there's a problem in our tax policy in that if this expenditure is carried out and it's not deductible as repairs, which is a fairly reasonable approach to take, what happens then? Well at present it's now capitalised as non-deductible because there's no depreciation available for buildings.
The Podium decision is correct in tax law to treat the expenditure as capital. The bigger problem I think we need to address from an economic policy perspective is we need to get buildings up to scratch because according to insurers we are considered as the second riskiest country in the world when it comes to natural hazards, behind only Bangladesh.
This risk is going to get bigger because climate change means more flooding and adverse weather events leading to increasing expenditure on repairing the damages. More or less simultaneously with the Te Anau earthquake there was extensive flooding in Kaikoura which temporarily closed State Highway One.
Thank God for Investment Boost?
The problem for building owners looking to bring their buildings up to the relevant code is if these costs are non-deductible then that makes it harder and more costly for them. Furthermore, such costs are non-depreciable unless, of course, the owner is able to use the investment boost allowance introduced last year.
But using the Investment Boost seems a roundabout way of dealing with the matter. It seems to me we really do need to step back and think in broader terms about the depreciation treatment for commercial buildings, factories et cetera. Is it right from an economic, social and safety policy perspective to require earthquake strengthening and other improvements such as healthy homes but deny deductions and/or depreciation for such expenditure?
Cutting depreciation to fund tax cuts
In the past 15 years, depreciation has been used twice by National party-led governments to fund tax cuts. Firstly in 2010 under Sir John Key’s government when Bill English was finance minister, then more recently in the 2024 Budget. Restricting building depreciation frees up cash for redistribution and tax cuts, but how does that encourage investment? In terms of tax policy, how do you reconcile the conflicting aims of public safety and cost? Something to press our politicians on during the election campaign.
Another reminder of the importance of keeping records…and an argument for a general capital gains tax
Moving on, Technical Decision Summary, TDS 26/08 involves the disposal of property and imposition of shortfall penalties. The background was the sale of property which was subject to tax under section CB 6 of the Income Tax Act 2007 and whether the taxpayer was liable for a shortfall penalty for gross carelessness or for taking an unacceptable tax position
The taxpayer in question was a company, and its activity was residential business property development. About 20 years ago the taxpayer purchased a property. Then nine years after purchase, the director of the company engaged architects to draw up house plans for part of that property, which was going to be his home.
The property was subdivided eight years ago into five lots and the section which had been subdivided as part for house plans was sold to a third party three years after subdivision. We’re therefore discussing a transaction that happened at least five years ago.
Gross carelessness or just unacceptable?
The sale was reported in the GST return but not in the income tax return and the two issues at stake with Inland Revenue were whether there was a purpose or intent to dispose of the section at the time of acquisition, and then did either the shortfall penalties apply for gross carelessness and an acceptable tax position?
Now, the upshot was that the taxpayer did have a purpose or intention to dispose of the section and had not proved otherwise. Fortunately, a shortfall penalty for gross carelessness, which is a 40% penalty of the tax due was considered not applicable. Instead, a 20% shortfall penalty for taking an unacceptable tax position applied.
Remember when?
The TDS highlights, yet again, the importance of keeping good records. It appears that the taxpayer spoke to Inland Revenue at the time of acquisition about what would be the tax treatment of this section. But he seems to have forgotten that discussion
Also, the taxpayer appears to have combined his personal intentions with those of the company. That's actually a pretty common occurrence in my experience. Clients often see companies and trusts as merely an extension of themselves even though legally, companies are legally separate entities and trustees are acting in separate legal capacities. So that was one of the reasons the taxpayer lost.
Paragraph 26, is interesting for its discussion about the passage of time involved:
“Consideration was also given to the elapsed time since acquisition and lack of records from that period. [The Tax Counsel Office] accepted that a reasonable person may not have remembered the statements made to Inland Revenue regarding the property acquisition about
15 years ago, particularly since the person would not have had access to Inland Revenue’s records of those statements. Therefore, it was possible a reasonable person in the Taxpayer’s position might not have foreseen the risk of a tax shortfall.”
This is why a gross carelessness shortfall penalty was not considered appropriate. However, the Tax Counsel Office considered case the tax position was clear, that if a taxpayer acquires land with a purpose or intent of disposal, section CB 6 applies and the disposal is taxable. Therefore, not returning the disposal in relation to this property was an unacceptable tax position.
An argument for a capital gains tax
Clearly, it’s important the taxpayer should have had better record keeping. Then somewhere along the line the discussion with Inland Revenue might have come up. Someone else might also have picked up on the question of if the sale was subject to GST, how might that affect the income tax position? This is a scenario we often encounter.
One of my arguments for capital gains tax is this issue of intent. What was my intention when I purchased that property 20, 30 years ago? That drops out of the picture completely under a capital gains tax regime. Very simply, if you've purchased a property or any asset and you dispose of it, then under a capital gains tax regime, some tax charge will be payable. How the gain is computed is where difficulties emerge. But as a basic principle, everyone knows where they stand.
But that's the sidebar in this TDS. The key point is with any land transaction is it is incredibly important to keep records of what the intentions were at the time of purchase. That will also include mortgage applications at the time and correspondence with agents and advisors. Inland Revenue has a track history of requesting those from banks which sometimes contradict what’s recalled years later.
Meanwhile, there’s an election this year
Finally, this week, we're coming up to the election, and the lines are forming as to what each party’s tax policies will be. Labour, as we know, has put out its proposal for a capital gains tax on commercial and residential property other than the family home.
At the time of recording National had not released anything, but it will probably be a steady as she goes approach with tax setting with a focus on better enforcement and simplifying the tax rules to ease compliance.
Robyn Walker at Deloitte has set out what’s happened in this space. The latest examples are the proposed FBT reforms, increased tax-free thresholds for not-for-profits organisations, and tidying up some of the complexities around Working for Families. Other changes include increasing the threshold above which the foreign investment fund rules from $50,000 to $100,000 and effectively doubling the thresholds for the financial arrangements regime. Both are significant changes for many of our clients.
The Green Party’s wealth tax proposal – landing in a “country more receptive”?
The Greens are going with a wealth tax which has prompted concerns over the potential flight effect of a wealth tax. There is no doubt a behavioural response to a wealth tax would be that those potentially affected could move overseas.
What caught my eye about the Greens' suggestion is an article in Business Desk by Dileepa Fonseka which suggested that the Greens are tapping into what was termed a rising thread of unhappiness with the tax system.
The story’s opening paragraph notes the Green Party's latest wealth tax proposal is narrower than its proposal in 2023, but “it lands in a country arguably more receptive to the idea of broadening the tax base.”
No longer a broad tax base and time for a more grown-up discussion?
The article also features commentary from John Cuthbertson, tax leader for the Chartered Accountants of Australia and New Zealand (CAANZ), and previous podcast guest. Although he saw several problems with the Green Party's tax ideas, the proposals did target an issue CAANZ had been trying to get political parties to discuss. As John noted
“New Zealand has always prided itself on having a broad base, low-rate tax system, but over time our broad base has shrunk to three key taxes, so our base isn't really that broad any longer.”
As a result, three taxes, income tax, GST and corporate tax were doing the “heavy lifting”. In John’s view the base needs to be broadened as the population ages, if the government wants to keep continuing delivering the same level of public services.
“What we've been trying to encourage is a more grown-up discussion about sustainability of our tax base for the mid to longer term and what that might need to look like.”
In John’s view the present Government budget deficits could only be fixed in three ways: new taxes, increasing the tax take via growth, or reducing the level of public services.
Labour and the Greens are proposing new taxes whilst National’s approach is you might call a lot of ‘One-percenters’, get more efficiencies, improve compliance by making it more frictionless, so to speak. Less friction in the tax system should mean more taxes collected.
To me, and John Cuthbertson addressing the deficit is not an “either, or” situation. Improved efficiencies are not going to be enough. We have a huge infrastructure deficit to deal with as well. It's like that old meme about why not both. It seems to be inevitably that's where we're going to land, that we will be looking to be as efficient as possible. Some things may no longer be fully funded, but other ways, some form of tax increases and changes to our tax system are, in my view, completely inevitable. The public's acceptance of that will be interesting to see.
And on that note, that’s all for this week I’m Terry Baucher and thank you for listening. Please send me your feedback and requests for topics or guests. Until next time, kia pai to rā. Have a great day.
We welcome your comments below. If you are not already registered, please register to comment
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.